There Are Reasons To Feel Uneasy About China Mengniu Dairy's (HKG:2319) Returns On Capital

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after briefly looking over the numbers, we don't think China Mengniu Dairy (HKG:2319) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Return On Capital Employed (ROCE): What Is It?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on China Mengniu Dairy is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.063 = CN¥5.0b ÷ (CN¥117b - CN¥38b) (Based on the trailing twelve months to June 2024).

Thus, China Mengniu Dairy has an ROCE of 6.3%. In absolute terms, that's a low return but it's around the Food industry average of 7.4%.

Check out our latest analysis for China Mengniu Dairy

In the above chart we have measured China Mengniu Dairy's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering China Mengniu Dairy for free.

How Are Returns Trending?

On the surface, the trend of ROCE at China Mengniu Dairy doesn't inspire confidence. Around five years ago the returns on capital were 9.5%, but since then they've fallen to 6.3%. However it looks like China Mengniu Dairy might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a related note, China Mengniu Dairy has decreased its current liabilities to 32% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

In Conclusion...

To conclude, we've found that China Mengniu Dairy is reinvesting in the business, but returns have been falling. And in the last five years, the stock has given away 45% so the market doesn't look too hopeful on these trends strengthening any time soon. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

On a separate note, we've found 1 warning sign for China Mengniu Dairy you'll probably want to know about.

While China Mengniu Dairy isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.